Crypto at the Macro Level
Cryptocurrencies have taken the financial world by storm. Whether Bitcoin, Etherium, or Dogecoin, or more exotic virtual coins like $wool, “crypto” seems to be everywhere. And opinions on it vary wildly: Critics insist that cryptocurrencies are a solution in search of a real problem and their rollercoaster valuations reflect a potential for dangerous economic instability (Noam 2018). On the other hand, crypto evangelists argue that these digital currencies are a major innovation that democratize finance, create efficiencies, and reduce dependence on central banks and governments. Regardless of the side of the debate, it’s impossible to deny cryptocurrencies’ impact and profile: Bitcoin skyrocketed from $426.84 to $59,822.90 per coin in the last five years (Sitar and Guide 2021). It even has a growing presence in pop culture- it’s hard to look away when Snoop Dog and Matt Damon appear in superbowl commercials for Crypto.com.
Beyond the hype, however, cryptocurrencies like Bitcoin raise serious macroeconomic questions to the extent that we consider to be a currency. Currencies have played a role in societies for thousands of years, bringing value to economies and facilitating transactions from ancient Athens to the modern-day United States. The emergence of digitally based coin systems, like Bitcoin, sits beyond existing institutions and regulations. They allow for more accessible and faster transactions while also encouraging entrepreneurship, investment, and innovation across global markets, but not without major costs. This raises a number of questions: What are the macroeconomic pros and cons of cryptocurrency, if we consider it to be a full-fledged currency? Should governments regulate or create their own digital currencies?
Macroeconomic Pros and Cons of Cryptocurrencies
A major strike against the widespread use of cryptocurrency is that it could lead to major financial instability. As “the counterpart of government issued currency”, cryptocurrency can damage central banks and monetary policymaking institutions that have a monopoly on producing traditional money (Noam 2018). If the money supply becomes composed of many private currencies rather than only one government issued currency, it increases the risk of inflation and hyperinflation in the long run. This is because when private entrepreneurs issue their currencies, they merely seek to maximize their profits, without consideration for externalities in the market. Whereas governments may mint additional coins to “account for price effects created for other participants in the market”, private entrepreneurs will produce more currency when their value is positive, regardless of the demand conditions in the market (Noam 2018). Therefore, without a centralized government cap on the number of units that can be issued, there are no incentives for private entrepreneurs to limit the number of units of currency they produce. This inevitably causes the value of all the digital currencies in circulation to diminish, eventually inviting a state of hyperinflation (Noam 2018).
Cryptocurrency also exists in an extremely deregulated market. While this has both positive and negative aspects, the volatility and riskiness of using cryptocurrency potentially outweighs the benefits of fast and democratized transactions. Its price in US dollars fluctuates wildly, and has reached up to a 20-30% change in a single day (Roubini 2018). A notable form of cryptocurrency that has perhaps escaped volatility are stablecoins, which are backed up by official currencies like the US dollar. A prominent stablecoin supposedly backed by the US dollar is Tether, which claims to have “a dollar in the bank for every Tether coin it has issued in circulation” (Noam 2018). However, the evidence that it did indeed have every dollar of the $2.8 billion it issued out in Tether coins has been weak, given the lack of auditing, a potential price manipulation scheme, and a theft of $31 million in USDT tokens (Noam 2018). This reflects the shortcomings of a crypto world lacking regulation and oversight, and issues like these may stand in the way of producing a legitimately stable crypto market price in the future.
Finally, the deregulated nature of the cryptocurrency market furthermore lends itself to a large amount of illegal activity. With no government oversight or protection, combined with the anonymity and security of transactions, crypto is quite attractive for money-laundering, fraud, tax evasion, extortion, and even terrorist financing. While authorities and governments may be able to trace an illegal transaction, they often cannot identify the parties involved (Adrian 2021).
Nevertheless, cryptocurrency has some distinct strengths as a currency. The greatest of these may be that cryptocurrencies, by their fundamental nature, allow for the democratizing of financial transactions. It enables more accessible and faster transactions, independent of banks and government institutions, and as such can encourage entrepreneurship, investment, and innovation across global markets. Even if banks and governments should still play a role in managing currencies and financial transactions (which many people believe), the remarkable speed and security of cryptocurrencies, and the blockchain technology underlying it, is difficult to overlook.
Government’s Reactions to Cryptocurrencies
Some countries have embraced the emergence of cryptocurrency because of its potential benefits for efficient transactions and decisions, while others have resisted it (Roubini 2018). China is one of the biggest countries that made efforts to curtail the spread of cryptocurrency in its economy. The country had the largest share of bitcoin mining in the world until the spring of 2021, when it banned the mining of bitcoin and then banned all cryptocurrency transactions altogether later on in September (Roubini 2018). It banned Bitcoin mining not only because of the threat to financial stability, but also because of the damaging environmental consequences of mining. The People’s Bank of China cited “the role of cryptocurrencies in facilitating financial crime as well as posing a growing risk to China’s financial system” as the main driver behind its ban. Another underlying reason was because of capital flight from the country, as investors moved their capital out of China amidst the trade war and devaluation of the yuan, with an estimated $50 billion outflow of cryptocurrency between 2019 and 2020 (Kharpal 2020).
The US, on the other hand, has not outlawed mining or use of cryptocurrencies, but is considering whether to issue a centralized bank digital currency (CBDC) that would have some of the advantages of unregulated cryptocurrencies without the macroeconomic risks to the broader economy. Crypto-evangelists would argue that avoiding government involvement in financial transactions is one of the benefits of private currencies like crypto. However, according to the Fed, a CBDC “could provide a safe, digital payment option for households and businesses as the payments system continues to evolve, and may result in faster payment options between countries.” Given the US’s dominant position in global finance, the Fed is proceeding slowly and will seek full support from the Executive branch and Congress in issuing any CBDC (Smialek 2022).
Moving Forward
It seems very likely that governments will step in and regulate crypto currencies, rather than allow a volatile and unregulated form of currency to potentially diminish central banks’ power to use monetary policy to manage the economy and protect individuals. However, what form this may take is still uncertain considering how recent the growth in cryptocurrency is.
Furthermore, it is far from certain that private cryptocurrencies will ever become currencies in the truest sense. At this point, they are being used as speculative investments. In other words, people are buying into crypto with the hope of selling it later at a higher price rather than using it as a currency. And with the intense “hype” surrounding it, the current crypto craze looks more like a dangerous bubble than the emergence of a viable new form of currency.
References
Adrian, Tobias. 2021. “Global Financial Stability Report, October 2021.” International Monetary Fund. https://www.imf.org/en/Publications/GFSR/Issues/2021/10/12/global-financial-stability-report-october-2021.
Kharpal, Arjun. 2020. “China users reportedly moved $50 billion of cryptocurrency out of country.” CNBC. https://www.cnbc.com/2020/08/21/china-users-move-50-billion-of-cryptocurrency-out-of-country-hinting-at-capital-flight.html.
Nabben, Kelsie. 2022. “Cryptocurrency has an impact on economies. That's why some are afraid of it – and some welcome it.” The Conversation. https://theconversation.com/cryptocurrency-has-an-impact-on-economies-thats-why-some-are-afraid-of-it-and-some-welcome-it-175911.
Noam, Eli. 2018. “The Macro-Economics of Crypto-Currencies: Balancing Entrepreneurialism and Monetary Policy.” Columbia SIPA. https://sipa.columbia.edu/sites/default/files/25222_SIPA-White-Paper-MacroEconomics-web.pdf.
Roubini, Nouriel. 2018. “Bitcoin is the mother of all bubbles, Roubini says.” MarketWatch. https://www.marketwatch.com/story/bitcoin-and-blockchains-broken-promises-2018-01-26.
Sitar, Dana, and Step Guide. 2021. “If You Bought $1 Worth of Bitcoin 5 Years Ago, Here's How Much You'd Have Today.” The Motley Fool. https://www.fool.com/the-ascent/buying-stocks/articles/if-you-bought-1-worth-of-bitcoin-5-years-ago-heres-how-much-youd-have-today/.
Smialek, Jeanna. 2022. “Fed opens debate over a U.S. central bank digital currency with long-awaited report.” The New York Times. https://www.nytimes.com/2022/01/20/business/fed-digital-currency.html.